What is foreign exchange risk?

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What is foreign exchange risk?

Post by Admins on Thu Nov 12, 2015 10:58 am

Foreign exchange risk is the risk investors face when converting their money in a foreign currency. The risk is present because in case of unwanted volatility in the value of a foreign currency, the worth of the investment can significantly decrease.
The Facts
An investment in a foreign currency is converted from the investor's home currency. If the conversion rate changes in an unfavorable way, the investor can lose a lot of money.

Multinational Enterprises
Multinational enterprises face sizable foreign exchange risk because they have businesses in more than one country. An unfavorable change in the exchange rate can increase their cost of capital. As a result, foreign exchange risk plays a big role in capital budgeting decisions.

Institutional investors face foreign exchange risk because after they sell off their investment, they need to convert it back to the original currency. This is also called currency risk or exchange rate risk; an investor risks losing money because of an adverse movement in the exchange rate.

For example, if a U.S. investor purchases stock in a British company, and the pound decreases in value relative to the dollar, after the investor closes out his position and converts the pounds back into dollars, he will ultimately lose a portion of the investment.

Companies that import and export as part of their businesses face foreign exchange risk. If the value of a currency goes up, the demand for that currency in the other country will go down because of the increase in price after its conversion.

Foreign Exchange Market
The value of each currency is determined through the buying and selling of currencies in the foreign exchange market.

foreign exchange risk business & money definition

Investopedia.com: Foreign-Exchange Risk


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